John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
Since mid-2012, gross domestic product growth has cracked the 3-per-cent mark in Canada in just one quarter. In the United States, meanwhile, recent growth has been some of the strongest we've seen since the economic recovery began in 2009, hitting at least 3.5 per cent in four of the past five quarters. And that doesn't come close to what growth has been in China, where GDP growth – though slowing – continues to be more than 7 per cent.
Numbers like those make it sound like a good idea to ditch Canadian stocks, right?
Not so fast. So often, the stock market and economy are presumed to be attached at the hip. But the historical figures show that strong GDP growth doesn't mean good stock returns are a sure thing. In fact, the numbers show that strong growth doesn't even mean good stock returns are likely.
Consider a 2009 paper authored by Rajiv Jain and Daniel Kranson of Vontobel Asset Management. They looked at GDP and stock return data in 16 developed countries from 1900-2002, using data from Elroy Dimson, Paul Marsh, and Mike Staunton's book Triumph of the Optimists: 101 Years of Global Investment Returns, with updated figures from University of Florida professor Jay Ritter. Mr. Jain and Mr. Kranson's conclusion: "The data clearly shows that, over long periods and when adjusted for inflation, stock market returns and GDP per capita growth are negatively correlated."
A similar study of 19 developed countries from 1970 to 2002 found a negative correlation between GDP and stock returns, while another analysis of 13 countries, mostly emerging markets, from 1988 through 2002 found only a "marginally positive correlation," Mr. Jain and Mr. Kranson wrote.
With stock market commentators so often basing their bullish/bearish stance on the economy, how can this be? Well, there are a number of reasons why GDP growth and stock market performance are not more positively correlated. Part of it is expectations. Stocks in high-growth areas often come with high price tags. Investors expect a lot from them, and anything less than "a lot" can mean trouble.
Also keep this in mind: Just as the stock market is a market of individual stocks, the economy is made up of all sorts of individual businesses. Even when overall growth is weak in a country, you'll still find individual businesses that are growing rapidly.
Given all of that, it's not surprising that my Guru Strategies are still finding plenty of good stocks in both the U.S. and Canada. I recently screened for stocks that get approval from at least one of my models and which have one-year and five-year EPS growth rates of at least 15 per cent. Here's a sampling of what I found. As always, you should invest in stocks like these as part of a broader, well diversified portfolio.
CGI Group Inc. (GIB): Montreal-based CGI ($13-billion market cap), which provides end-to-end IT and business process services to clients across the globe, has a 20.8-per-cent long-term growth rate (I use an average of the 3-, 4-, and 5-year EPS growth rates to determine the long-term rate). That strong growth is a big reason it gets strong interest from my Peter Lynch-based strategy. Mr. Lynch, one of the most successful mutual fund managers of all time, used the PE-to-growth ratio to find attractive growth stocks. With a P/E ratio of 15.0 and that long-term growth rate, CGI has a PEG ratio of 0.72, coming in well below this model's 1.0 upper limit.
Catamaran Corp. (CCT): Based in Illinois, this pharmacy benefits manager has multiple locations in the U.S. and Canada and manages more than 350 million prescriptions each year on behalf of over 32 million members. The $12-billion-market-cap firm has grown EPS at a 38-per-cent pace over the long term. My Lynch-based model thinks that makes its 36.4 P/E ratio worth it, as those two figures make for a 0.95 PEG ratio. It also likes that Catamaran's debt/equity ratio is a reasonable 29 per cent.
Syntel Inc. (SYNT): Michigan-based Syntel provides business analytics, cloud computing, IT infrastructure management and other services. The firm ($3.8-billion market cap) has grown EPS at a 20-per-cent pace over the long term, and revenues at a 16-per-cent pace.
My Lynch-based model likes Syntel's 15.2 P/E ratio, 0.75 PEG, and 15.5 per cent debt/equity ratio. My Warren Buffett-based model, meanwhile, likes that it has upped EPS in all but two years of the past decade, has almost twice as much in annual earnings as long-term debt, and has a 10-year average return on equity of 29 per cent.
Disclosure: The author is long SYNT.
John Reese